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Economy

Tse and Meller -- Chinese companies lead the way in fintech innovation

With the Chinese government keen to encourage innovation in the financial industry, the fintech revolution is quickly gaining pace.

Financial technologies companies backed by Chinese venture capital raised $2.4 billion in the first quarter of 2016, according to accounting firm KPMG. This represented a 49% share of global fintech investment in the period, bigger than that of North America and Europe combined.

Ant Financial Services Group, Alibaba Group Holding's fintech affiliate, itself raised $4.5 billion in April, making it the largest round of funding for a fintech company in the world. Four out of the five largest fintech companies in the world by valuation are now in China, according to Jason Jones, chief executive of lending industry events group LendIt: Ant Financial; Shanghai Lujiazui International Financial Asset Exchange, or Lufax, which operates as Lu.com; Zhong An Online Property and Casualty Insurance and JD.com's JD Finance. And this market is only set to grow.

The majority of China's leading fintech players are also its internet giants. Their digital platforms have amassed user bases that have then gone on to serve as the launch point for fintech endeavors. Alibaba and Tencent Holdings dominate the online payment market in China, scaling up faster with convenient financial services that traditional lenders can't match.

Compared with fintech, China's financial system is relatively immature. According to the Mintai Institute of Finance, nearly 80% of small- and medium-sized enterprises in China are not adequately served by banks. The People's Bank of China has found that about three-quarters of the general population is "underbanked" and lack access to financial services.

It is these gaps that allow innovative outsiders to enter the market. This is apparent in the area of credit scoring where the lack of an established model has created the opportunity for internet players to step in.

Ant Financial developed Sesame Rating, China's first credit scoring system. It uses big data to analyze the purchasing behavior of users on Alibaba's e-commerce platforms to judge their creditworthiness based on a number of factors.

Chinese entrepreneurs' willingness to experiment means products and services hit the market quickly and evolve quickly. Initially, AliPay, Ant Financial's payment service, was used only as a payment method for Alibaba's e-commerce platform. Now, AliPay can be used at brick-and-mortar stores, for utility bills and even for overseas shopping.

China has become fertile ground for fintech solutions. Online wealth management has gained traction among young middle-class consumers. As more risk-tolerant investors, they tend to favor equities and mutual funds over traditional savings accounts. At $66.9 billion in 2015, China's peer-to-peer lending market is now the world's largest and more than four times the size of its U.S. counterpart.

However, the P2P market has been plagued by inadequate regulation and hence, a high frequency of frauds and scams such as the $7.6 billion Ezubao Ponzi scheme uncovered last year. Regulators have since started to get a grip on the sector. After an initial series of regulations were issued at year-end, some 1,600 P2P companies shut down during the first half of 2016. Another series of rules issued in August further restricted the scope of activities permissible to P2P companies, barring them from creating asset pools or providing loan guarantees.

Chinese fintech players are also moving into the nascent blockchain industry. Ping An Insurance Group, one of China's largest insurers and the owner of Lufax, in May became the first Chinese entity in a global blockchain consortium with Goldman Sachs and Barclays.

Some Chinese companies are leading the pack. Wanxiang Blockchain Labs, a think-tank that is to host the Global Blockchain Summit in Shanghai in late September, is behind ChinaLedger, an alliance of 11 regional commodity, equity and financial asset exchanges that plan to establish an open-source blockchain protocol.

Existing networks help

China's internet giants have some of the most sophisticated fintech ecosystems. Apart from Alipay and Sesame Credit, Ant Financial also owns Yu'E Bao, China's largest money market fund. Yu'E Bao raised $90 billion in its first 10 months and accounts for approximately one-fifth of China's 4.2 trillion yuan ($630 billion) money market fund sector. Ant Financial's portfolio also includes digital banking, microloans, securities, crowdfunding and other wealth management products.

Tencent founded WeBank, China's first online only bank, in 2014. WeBank offers consumer, corporate and international banking services. By May 2015, it had launched a personal credit line service to select users without guarantee or collateral through Tencent's QQ and WeChat messaging platforms. Unlike Ant Financial, WeBank acts as a platform connecting borrowers and lenders directly rather than from its own balance sheet, allowing it to avoid credit risk.

Lufax, launched in September 2011, is China's first online investment and financing platform. It became the world's most valuable fintech startup in January after raising $1.2 billion on a valuation of $18.5 billion before getting eclipsed by Ant Financial. Mostly known for its P2P lending service, Lufax's larger ambitions are embodied in its "9158 strategy" to offer products across various sectors of the finance industry via its platform. By the end of 2015, it had signed up 500 institutions across more than 300 cities.

Zhong An, China's first digital insurance platform, was jointly launched in November 2013 by Alibaba, Tencent and Ping An. The idea behind Zhong An was to digitize the user experience and insurance value chain. By using the unique capabilities and user bases of its stakeholders, Zhong An was able to launch innovative insurance products that targeted China's digital economy as well as more traditional liability and property insurance products. In its first year, Zhong An underwrote 630 million insurance policies for 150 million clients.

Chinese fintech companies are now starting to expand overseas. In September 2015, Ant Financial acquired a majority stake in Paytm, India's biggest online payment company, to gain access to a massive population just beginning to embrace mobile payments. Tencent's Wechat Pay has now turned into a global wallet for Chinese consumers after it launched clearance services for nine different foreign currencies and built partnerships in 20 countries. Tencent itself has entered the South African market through an alliance with Standard Bank to launch a mobile payment system targeting the emerging middle class.

While the Chinese government is encouraging innovation and technology investment to modernize the financial industry, it is still trying to draw up an appropriate legal framework that wouldn't stifle growth. The regulation of financial services in China is overseen by multiple bodies with overlapping policies and sometimes unclear guidelines. But there have been concrete developments over the last year. In July 2015, central government ministries jointly issued guidelines that clarify responsible regulatory bodies and roles, as well as legal parameters for specific sectors of fintech.

China's fintech revolution is already making huge waves. Opportunities are abundant for those able to provide innovative solutions to address critical consumer needs. The impact of China's fintech innovation, whether in the realm of online payment, wealth management, crowdfunding or elsewhere will be seen and felt worldwide. The foundation established by this pioneering class of Chinese fintech companies will set the stage for even more exciting players to emerge.

Edward Tse is founder and CEO of Gao Feng Advisory Co., a global strategy and management consulting company, and the author of "China's Disruptors" (Portfolio, 2015). Ian Meller is a consultant at Gao Feng.

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